Africa Finance Forum Blog

"The industry of banking and finance is not only entering the age of algorithms but also the age of disintermediation."

In this exclusive interview, Arshad Rab, Chief Executive Officer, European Organisation for Sustainable Development (EOSD), spoke to Jide Akintunde, Managing Editor, Financial Nigeria magazine, on the disruption of conventional finance and the future of the financial services industry.

Jide Akintunde (JA): The disruption of the financial services industry is underway. Is this something that will prove ultimately evolutionary or revolutionary in the provision of financial services?

Arshad Rab (AR): For centuries, the provision of financial services was the sole domain of banks. But that is no longer the case. Financial services are now increasingly being provided by technology companies, heralding the tectonic shift currently taking place.

The industry of banking and finance, as we currently know it, will cease to exist and this will happen much faster than many of us think. So, if we look at the emerging big picture, we can conclude that the change in the financial services industry will indeed prove to be revolutionary.

JA: Why is this happening?

AR: The disruptive nature of technological change is reshaping every aspect of our lives. We have entered the age of algorithms and artificial intelligence (AI) and computer machines are taking over much of the work humans currently do, significantly, including decision-making. Therefore, the technology companies are in a much better position than the banks to take full advantage of latest innovations and make banking and finance their business domain.

On the demand side of financial services, we are also experiencing a radical shift in the customer behaviour. Today, we all expect things to be done much faster than say five years ago. For example, people have problems in understanding why in this digital age, banks need days to transfer money. We can of course offer reasons for the time lag such as regulations for clearing houses, but most people will not be satisfied with such explanations. The customers of today want money to be transferred instantly; they would like loan decisions to be made quickly; and they want to be able to enjoy banking services from any device, at any time and from anywhere.

Another factor influencing financial services is the growing population of young people who are tethered to mobile devices. The services that are not available on those devices are simply non-existent as far as the younger generation are concerned. This generation, quite often referred to as millennials - which generally means the people born between 1980 and 1997 - are becoming entrepreneurs, decision-makers and customers. They need technological and speedy solutions much more than the older generation. And the centennials, those born after the millennials, are now a big market for consumer electronics and IT products and services. In the next few years, they will be one of the largest customer groups for financial institutions.

And let me also underscore a very key point: The competitive edge that the algorithms and artificial intelligence-driven technologies enjoy is that they are much faster and less prone to errors than humans - including in making decisions - making them very attractive for the financial services they offer.

So, one could argue that what is happening currently, particularly the proliferation of algorithms, artificial intelligence and blockchain, will make banking more a business of technology companies than of the banks. Referring back to your first question, this is a revolutionary change in the history of banking and finance.

JA: What is the real hope of a better future of banking and finance that is deliverable by the disruption of conventional finance?

AR: There are two words that immediately come into my mind: Inclusive and democratic. First, through the use of technology, banking services are being made available to unbanked and underbanked customers at affordable costs. The massive and fast growth in inclusive banking and finance, to a large extent, is because of technological advances.

Secondly, I can see the emergence of banking for the people, of the people and by the people. For example, if we look at crowd funding or peer-to-peer real-time payment solutions, you can clearly see that the industry of banking and finance is not only entering the age of algorithms but also the age of disintermediation. The role of financial intermediaries, be it commercial banks, development finance institutions or other intermediaries, will continue to reduce. And as blockchain technology becomes real, the financial services industry will experience historic disintermediation. This will make banking and finance more democratic than ever before.

JA: We see that in e-payment there is tension between conventional banks and the telcos. Also, the regulatory and consumer protection frameworks for fintechs are, at best, work in progress. Should the efforts at resolving the issues assert competition or cooperation?

AR: The role of regulators should continue to be about protecting the public interest. There can and there should be no compromise on this issue as we transform from conventional to digital banking and finance. In the emerging scenario, there is a dire need for actions that can create a level-playing field for both incumbents and new players such as the financial technology companies.

Since there is a real prospect that few big tech giants will dominate the financial services industry within the next few years, we need policymakers and regulators to act fast to ensure safe, fair and competitive markets and to avoid market domination by a handful of powerful players. A good regulatory framework, as always, will promote competition. This is in the interest of the society and in the long-term interest of all the current and future players.

Now, talking about cooperation, this is currently being led more by market dynamics than by regulatory pressures. A growing number of incumbent financial institutions are closely collaborating with small and medium-size fintechs to overcome technological challenges. In fact, this is one of the top trends happening today and some of the banks have even started to acquire fintech startups. Nevertheless, there will still be existential threats looming over the incumbents, including the big financial sector players.

Technology, market conditions, regulatory framework and socio-economic and political climate will continue to change extremely fast. However, the organizational structure and business processes of the incumbent financial sector players are not very responsive to the fast-changing environment, at least not in comparison with the fintechs.

JA: One issue that has been little highlighted is that disruptive finance can be zero-sum. While the fintechs are already helping to drive down the cost of financial transactions - especially remittances, aggregate labour in the financial services industry can be eroded. Do you have concerns about this trade-off?

AR: There is no doubt that a lot of work done today by humans will be done by robots in all sectors of the economy, and the financial services industry will not be exempted. But do we have a choice? Since we know that digitization of everything is unstoppable, it is time to move forward and meet the challenge head on. This means embracing the technological innovations and getting ready to benefit from the digital economy.

For instance, imagine if we could soon free up almost 50 percent of the world's human resources by taking them away from doing monotonous tasks and deploying them to do creative work. And imagine if we could enable majority of the world's workforce to unleash its true talent and potential, all because for the first time in human history, it is now possible to do so - thanks to technology. And let there be no doubt: All monotonous jobs can be and will be taken over by robots.

Nonetheless, my concern is not about the threat that technology poses to human labour. We cannot "undigitize" the economy or halt further developments, anyway. I am earnestly concerned that governments, regulators, businesses and society are not realizing the pressing need to take immediate and resolute actions to ensure a smooth transition to the age of algorithms and artificial intelligence. The danger of mass unemployment and destabilizing markets is real but preventable, provided we act fast and smart.

So, I am calling for urgent actions and inviting the stakeholders to work together to create a win-win outcome and not wait till the water runs dry.

JA: The EOSD has been encouraging financial institutions in the global South to embrace Sustainability. What would be your message to African banks on how they should continue to position for the future of banking and finance?

AR: This is a difficult question to answer in few words. However, I would like to suggest that banks must embrace technology and use it to its full potential. But let me hasten to add that investments in technology alone is not enough because it is very challenging to keep up with the fast pace of technological change. For the incumbents, it will be too tough to compete on the basis of technological edge with the tech giants and other fintechs entering financial industry.

In my opinion, the financial institutions, irrespective of their location, size and infrastructure - and in addition to full-scale digitization - need to focus immediately on true value creation for all stakeholders. The successful financial services providers will be those that deliver real socio-economic value in their communities and to society at large, while fully recognizing the natural environment as one of the key stakeholders. This is not only the right thing to do from a moral perspective. But, at the end of the day, this is where the battle for survival will be won or lost.

Arshad Rab serves as the CEO of the European Organisation for Sustainable Development (EOSD) which is a dedicated body that has in its unique charter the purpose of developing strategies, programs and initiatives and undertaking projects that contribute in implementing the EU Strategy for Sustainable Development. Having his academic background in business administration, extensive work experience with private, public and multilateral organizations and wide-ranging in-depth knowledge, expertise and experience in the field of sustainability sciences, Mr. Rab today is a powerful voice on innovating for a sustainable future and leading with responsibility in times of disruptive change. His ongoing research interest include disruptive innovation in the financial services industry. In addition, he is the initiator of the Global Sustainable Finance Network that brings together about 70 financial institutions from over 30 countries.

In Tanzania, access to financial services for the unbanked expanded drastically when convenient and relatively cheaper options became available to receive and send money through simple feature mobile phones.

Four mobile network providers were in stiff competition in a market of 39 million registered mobile wallets (this registered wallet number does not include multiple wallet holders nor some of the dormant wallets from providers that did not exclude them after recycling their mobile numbers), 13 million of which were active ("active wallets" refers to the use of a mobile money account at least once in 90 days. This is the total number of all active accounts in the referenced month). This was in October 2014, when three of the four mobile money providers signed on to interoperability and made Tanzania the first country to successfully develop and implement standard business rules for interoperability (Source IFC: Achieving Interoperability in Mobile Financial Services: Tanzania Case Study).

By February 2016, the fourth provider had signed on and Tanzania was a global leader in the interoperability of digital financial services delivered by mobile network providers. How did this happen? This article highlights the key factors contributing to DFS interoperability in Tanzania.

Establishing an enabling environment

A regulatory environment nurturing competition and cooperation provided a foundation for dialogue and engagement around interoperability. The Bank of Tanzania, the country's central bank, played a monitoring role, ensuring that DFS providers offered services in compliance with risk mitigation frameworks (guidelines were issued that emphasized the use of international standards) that supported the dual objectives of financial stability and financial inclusion. This led to policies advocating for non-exclusivity in the use of mobile money agents and ultimately to agent interoperability. However, as the market continued to grow and mature, some market players demanded interoperability to kickstart client uptake, which had not seen rapid growth. Comprehensive interoperability was a clear need.

The Bank had to assume a leadership role in the push for sustainable interoperability. It opted for a market-based approach to interoperability, which was backed by evidence, and began to coordinate the process. It approved a neutral market facilitator, the International Finance Company (IFC) and the Financial Sector Deepening Trust (FSDT) of Tanzania, to facilitate engagement with DFS providers and reach agreement on an interoperable solution.

A market approach works

The IFC facilitated the industry-led interoperability project, with financial support from The Bill & Melinda Gates Foundation and the FSDT. This involved coordinating industry meetings to develop and reach consensus among mobile money providers on business rules and commercial agreements for interoperability and submit them to the Bank of Tanzania for consideration. This exercise began in September 2013 and, after several meetings in which participants reached a greater understanding of the regulatory framework, market demand, payment systems and rule development, consensus was reached. A year later, in September 2014, two of the four mobile network operators (MNOs) signed off on the wallet-to-wallet operating rules, which led to technical arrangements to initiate interoperability. In December 2014, the third MNO came on board. It took another year for the fourth to sign on, and by February 2016, Tanzania was one of the first markets in the world to have full interoperability of mobile money services (Figure 1).

Other markets could learn lessons from Tanzania's journey. It is worth noting that although Tanzania was well-suited to a market-based approach to interoperability, with its supportive central bank, conducive regulatory framework, and a sufficient level of market competition and maturity, two other factors played an important role: (i) the value proposition for the private sector was taken into account; and (ii) private and public sector dialogue was enhanced through the public policy lens of financial stability and financial inclusion. This helped the regulator balance its dual mandate and ensure financial inclusion initiatives do not compromise financial stability.

The next frontier

Tanzania's interoperability journey is still underway: the market is currently expanding the use case for interoperable services through merchant payments and extending interoperable services beyond MNOs to banks and other players. This will also involve improving the clearing and settlement process, shifting from bilateral arrangements to a multilateral process that includes a switching process. The Bank of Tanzania is continuing to play a monitoring role and provides guidance and direction on a process that is efficient and creates value not only for market players, but also for users and other stakeholders. In the end, this will ensure the best solutions are implemented and satisfy both private sector and public policy objectives-a task guided by the same principles that led to interoperability in the first place.

Kennedy Komba is currently Head of Strategy and Member Relations of Alliance for Financial Inclusion. Prior to this new role which he assumed in April 2016, he was the Senior Advisor of the National Payment System in the Bank of Tanzania. He is an Accredited Fellow of Macro-economic and Financial Management Institute of Eastern and Southern Africa (MEFMI) and a Fellow of Fletcher Leadership School for Financial Inclusion of Turf University, USA. He has experiences in financial inclusion policy, strategies and regulatory frameworks. He was instrumental in leading the development of the Tanzania regulatory framework for the National Payment Systems including electronic money regulations. He also was involved in the development of the Tanzania National Financial Inclusion Framework.

The global financial crisis has highlighted the vulnerability of financial systems and stressed the need for improving the management of financial vulnerability. The financial stability issue in low-income countries (LICs henceforth) has received less attention in recent years, insofar as they have been less impacted by the global financial crisis than emerging economies. However, a better understanding of financial fragility mechanisms in LICs is crucial. The experience of LICs shows that they could suffer sharp increases in non-performing loans and banking crises, and that the cost of banking crises is high, even if the banking sector is small.

In a recent paper, we investigate the determinants of financial fragility in advanced and developing countries, focusing on the interaction between credit booms and credit information sharing systems. A large number of studies have shown that excessive credit booms are one of the main drivers of financial crises. The development of credit information sharing (CIS) institutions may attenuate the negative effect of credit booms and/or limit the occurrence of such booms.

First, CIS can mitigate the negative effect of credit booms. A rapid growth of credits can weaken the quality of credit screening. During credit booms, credit officers cannot devote sufficient time to correctly screen new projects and bad projects have a higher probability of being financed. The presence of efficient CIS institutions could attenuate the negative effect of credit booms with screening. In addition, credit booms often fuel a rapid rise in asset prices (real estate and equity bubbles). Since assets may be used as collateral, the price rise will itself help an acceleration of credit growth ("financial accelerator") and reinforce the deterioration of screening. The presence of information sharing mechanisms may allow banks to diversify their portfolio. This diversification can limit the increase of asset prices induced by rapid credit growth, and therefore limit the detrimental impact of such episodes.

Second, CIS might affect the occurrence of credit booms, even if its effect is theoretically unknown. On the one hand, information sharing may curb credit growth by avoiding some customers borrowing from several banks. On the other hand, a reduction in the information asymmetries across banks may lead to an easing of lending standards and, in turn, an increase in the volume of lending (lending boom). Mechanisms through which CIS alleviates the detrimental and occurrence of credit booms can differ between developing countries and industrialized economies.

In order to identify the impact of information sharing and its transmission channel, we built a dataset combining a bank-level and country-level database. The sample included 159 countries with 79 developing countries and 80 emerging and developed countries over the period 2008-2014. To study whether developing countries differ from other countries, two groups of countries were distinguished: countries with a GNI per capita below US$ 4,125 in 2014 (n=79, called developing countries) and countries with a GNI per capita exceeding US$ 4,125 (n=80, called developed and emerging countries). Financial fragility was assessed by scrutinizing annual changes in the ratio of NPL to total loans. Episodes of financial fragility were identified every time this ratio jumped by at least 3%. This measure enabled capturing all episodes of financial distress and not only the extreme ones (banking crisis). The development of CIS was assessed by the depth index and the coverage of CIS. Both were extracted from Doing Business.

Estimations confirmed findings from other papers by highlighting the stabilizing impact of CIS. The paper also documented that this result held for both less developed countries (GNI per capita below US$ 4,125) and other countries (advanced and emerging). In a second step, the complex relationships between CIS, credit booms and financial fragility were analyzed. Econometric estimations pointed out several important results: (i) information sharing development had a direct effect on financial stability, even when the impact of credit booms was taken into account; (ii) the higher the scope of information collected, the lower the likelihood to observe a credit boom (but the coverage of CIS did not matter); this effect was smaller and less significant in developing countries; (iii) CIS mitigated the detrimental effect of credit boom but this result held only for advanced and emerging countries; and (iv) credit booms were strong predictors of financial vulnerability, especially in advanced and emerging countries.

These results have several policy implications. First, credit growth is a key variable for macro-prudential policies in low and middle income countries. Second, current efforts to develop CIS schemes should be strengthened, since the latter allow for credit expansion without excessive increase in the overall credit risk. Third, CIS has little impact on credit booms in developing countries, which justifies the extension of other tools - such as macro-prudential policies - to prevent excessive credit growth. Finally, extending the coverage of information sharing systems is not enough, since depth of information sharing is more efficient in avoiding credit booms.

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About the Authors

Florian Léonis currently a postdoctoral research fellow at CREA (University of Luxembourg). Samuel Guérineau is an Associate Professor at the Université d'Auvergne.

This work is part of a research project which received financial support from the DFID-ESRC Growth Research Programme (Grant No. ES/L012022/1). Other project's contributions focus on the implications of capital flows (FDI, aid, remittances) on long-term growth. All contributions are available and can be commented on the blog dedicated to the project.

Last month, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the African Development Bank, the Making Finance Work for Africa Partnership (MFW4A), FSD Africa, FIRST Initiative and the Initiative for Risk Mitigation in Africa (IRMA), also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.

In this first instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at some of the major takeaways of the conference.

What is fragility?

Using a "harmonized definition," the African Development Bank (AfDB), the Asian Development Bank, and the World Bank classify states as being fragile when they exhibit poor governance or when they face an unstable security situation. For practical purposes, governance is measured by the quality of policies and institutions (states with a CPIA score less than or equal to 3.2) and insecurity is assessed by the presence of United Nations or regional peace keeping operations (PKO). In sub-Saharan Africa most fragile states are also low-income countries (LICs).

While the focus of the "harmonized definition" is on institutions and insecurity, participants stressed that fragility is a multi-faceted concept. In particular, fragility implies weak state institutions, poor implementation capacity, underdeveloped legal and financial infrastructure as well as low social cohesion and the exclusion of a large share of the population from financial and other services. The nature of fragility is also fluid and fragile states face situations ranging from violent conflicts to post-conflict economic recovery. The sources of fragility go beyond poor governance, low GDP per capita, and conflicts to include vulnerability to commodity shocks and other macroeconomic shocks, and exposure to the risk of pandemics.

The need to broaden the definition of fragility was further explored with reference to a quote from President Ellen Johnson Sirleaf of Liberia "fragility is not a category of states, but a risk inherent in the development process itself". Mr. Sibry Tapsoba, Director of the Transition Support Department of the AfDB argued for a multidimensional approach, which applies a fragility lens to (i) look beyond conflict and violence; (ii) focus on inclusiveness and institutions; (iii) recognize the importance of the private sector; and (iv) recognize the presence of asymmetries in resources, policy, and capacity.

Participants also insisted on the need to go beyond the negative connotation of fragility and recognize instead that fragile states are in transition and present opportunities for human and financial sector development.

What role for financial sector development (FSD) in fragile countries?

Empirical evidence points to the positive role that financial sector development (FSD) can play in fragile countries. There is a positive correlation between financial sector and economic growth, poverty reduction, and inequality reduction. FSD can be a driver of growth through increased job creation and it can help mitigate risks through increased savings, loans, and insurance.

A key finding stressed by Ms. Emiko Todoroki, Senior Financial Sector Specialist at FIRST Initiative is that fragile countries fare worst in all macro and financial metrics, except one: the share of adults with mobile accounts. Digital financial services are offering solutions in fragile states and there is a need to understand better their role.

In the same vein, Ms. Thea Anderson, Director at Mercy Corps argued for the need to focus in on micro issues such as the role of delivery channels, payments infrastructure, insurance, and blended finance (including impact investment), and Islamic finance. As she noted, FSD is relevant even in the more volatile security situations. For instance, refugees and internally displaced persons (IDPs) can be viewed as a market segment and their financial inclusion can be kick-started with the use of functional identification (which also help comply with Know Your Customer (KYC) requirements). Mr. Paul Musoke, Director of Change Management at FSD Africa also highlighted the role of markets and market building in a difficult context. He noted the need to look for scale, sustainability, and systemic change. As markets are dynamic and not predictable, taking a systems approach can be useful. Such an approach includes asking questions such as what factors are going to play a role in the future? Who is going to pay for infrastructure? What level of development should we target?

Lastly, Mr. Cedric Mousset, Lead Financial Sector Specialist, World Bank reminded the audience that governance remains a key dimension of fragility. Weak governance in fragile countries exposes them to a higher risk of non-compliance with regulations such as anti-money laundering and combating the financing of terrorism (AML-CFT) regulation. Improving governance, although it may be a slow process, is needed to support FSD. Measures to support political stability, improve the business and macroeconomic environment, ensure legal security, and build capacity remain important.

As Nigeria rolls out one of the developing world's most ambitious policy platforms to boost digital payments and drive greater financial inclusion, it's important to take stock of the country's progress to date, so that policy-makers around the world can learn from Nigeria's experiences.

To this end, the Better Than Cash Alliance has just released two pivotal studies documenting Nigeria's digital journey, including the prospects for further progress in key areas, and four in-depth case studies which, whilst not a representative sample of all large businesses, nonetheless provide several important lessons.

In aggregate, the studies paint a mixed but broadly encouraging picture of Nigeria's success. The transition from cash to digital payments is progressing at very different speeds in different sectors of the economy and by different payment type.

The most promising findings relate to mass payments from a single payer to many payees ('bulk payments'). On this front the Nigerian Government is leading by example, making all of its pension payments, supplier payments and payments to state and municipal governments electronically, along with 61% of its salary and social subsidy payments. Importantly, the Government's leadership has created momentum that is combining with the Central Bank of Nigeria far-reaching Cash-less Nigeria program and driving significant progress towards digital payments among large businesses.

Cash-less Nigeria entails a wide range of policy initiatives ranging from public information campaigns, point-of-sale guidelines and restrictions on cash-in-transit services, and fees to disincentivize cash withdrawals. It is supported by the National Electronic Identity (e-ID) Card, a national ID that citizens may also choose to activate as a MasterCard-branded payment card. The policy was first implemented in 6 states (Lagos, Rivers, Anambra, Abia, Kano, and Ogun State) and the Federal Capital Territory (FCT), and it was rolled out nationwide in 2014.

As an indication of progress in Nigeria's corporate sector, as of 2013 large businesses now pay 61% of salaries electronically (compared to 31% in medium businesses, and 15% in small businesses). Indeed, one of the key insights to emerge from BTCA's studies is that digital payments now appear to have passed a tipping point in Nigeria's corporate sector, with the result that for large businesses it is not a question of whether to make the transition to digital payments, but rather one of when and how.

However, for other payment types the progress has been more modest. Although they exist, when it comes to payments by many payers to one payee (e.g. consumers paying a utility company or the national tax authority) digital payment options have not been widely utilized. Factors contributing to this low take-up include an absence of aggressive marketing of digital payment options by utility and other consumer-facing companies, the ubiquity of cash payments, and the large portion of the population that does not have a bank account.

Payments by individuals to one commercial payee (ie. a merchant) make up the overwhelming volume of payments in Nigeria, as it does in many markets. In this category, only 1% of payments by volume are currently being made digitally.

Several key barriers to the faster digitization of payments emerged from the Better Than Cash Alliance's studies. Chief among them is the widespread concern among individuals and small businesses about the scrutiny and consequent tax obligations they will face if they adopt digital payment tools. At the same time, there also exists a broad lack of understanding among individuals and small businesses of the benefits of going digital. There is a clear need for more public education campaigns to fill this knowledge gap. That being said, there is also evidence from a 2014 survey of 600 small businesses that some merchants are starting to recognize some of the key benefits, such as better record-keeping tools.

Also central to the findings is recognition of the need for better infrastructure and stronger incentives to drive change forward. While digital payment infrastructure is advancing rapidly in Lagos, and to a lesser extent in other major cities, it is, unsurprisingly, far less developed in rural and remote areas. Action is needed to overcome these digital gaps.

It is also noteworthy, that debit cards have been widely issued to Nigeria's urban and banked population, but consumers overwhelmingly only use them for cash withdrawals (which are generally free), rather than to make payments at the point-of-sale (POS). This low demand among consumers for digital point-of-sale facilities in turn means merchants have little incentive to invest in digital POS facilities, such that "the use of cards at merchants appears to be at a standstill", according to our analysis.

These are the types of challenges that Nigerian policy-makers will need to address with a new round of targeted initiatives if Nigeria is to build on its successes and aggressively drive greater financial inclusion through digital payments. Happily, the ambition and leadership the Government and Central Bank of Nigeria have already demonstrated augurs well for the future.

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Camilo Tellez-Merchan is the Knowledge and Research Manager for the Better than Cash Alliance. Prior to joining BTCA, he worked at CGAP in Washington and the GSM Association in London where he supported providers in the area of digital financial services. He has also worked at the UN Economic Commission for Asia and the Pacific in Bangkok, and at the Microsoft Labs in Bangalore where he conducted ICT4D research in the technology for emerging markets team.

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